Multiple Buffer CoCos and Their Impact on Financial Stability

Tinbergen Institute Discussion Paper 2020-010/IV

48 Pages Posted: 12 Mar 2020

See all articles by Ioana Neamtu

Ioana Neamtu

University of Amsterdam - Amsterdam School of Economics (ASE); Tinbergen Institute

Multiple version iconThere are 2 versions of this paper

Date Written: January 29, 2020

Abstract

In this paper we develop a theoretical model to investigate the effect on a bank's financial stability of having multiple contingent convertible bonds buffers (CoCos) on the same bank balance sheet, using cash-in-the-market pricing and global games methodologies. Contingent convertible bonds are meant to act as a bail-in mechanism for banks, where CoCo debt converts into equity when a bank needs it the most. We find that having CoCo buffers which trigger at different capitalisation levels can be detrimental for the CoCo bail-in capacity. Market-based triggers lead to premature conversion and fire-sales of equity. In contrast with existing literature, we show that book-based trigger CoCos yield an optimal outcome, as long as they incorporate expected credit losses.

Keywords: contingent convertible bonds, fire sales, financial stability

JEL Classification: G38, G21, G32

Suggested Citation

Neamtu, Ioana, Multiple Buffer CoCos and Their Impact on Financial Stability (January 29, 2020). Tinbergen Institute Discussion Paper 2020-010/IV, Available at SSRN: https://ssrn.com/abstract=3534968 or http://dx.doi.org/10.2139/ssrn.3534968

Ioana Neamtu (Contact Author)

University of Amsterdam - Amsterdam School of Economics (ASE) ( email )

Amsterdam
Netherlands

Tinbergen Institute ( email )

Burg. Oudlaan 50
Rotterdam, 3062 PA
Netherlands

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